Sep 23, 2020 02:11 PM

Fisher: Proverbs for Stock Market Pessimists

Investors check out the stock board on July 10 in Jiujiang, East China’s Jiangxi Province.
Investors check out the stock board on July 10 in Jiujiang, East China’s Jiangxi Province.

Ken Fisher is the founder and executive chairman of Fisher Investments.

Are Chinese stocks in a bubble set to burst? Western pundits sure think so, arguing the CSI 300’s big 37.7% surge from March 23’s lows — and its related 17.8% rise this year to date — is disconnected from reality. They point to disastrous floods in Hubei province, worries of a coronavirus resurgence, fears of weak trade tied to poor global economic conditions — and a rekindled American trade spat. They think Chinese investors should get out before markets implode like in 2015. But, now is time to remember the old Chinese proverb: “Control your emotions or they will control you.” Put your fears in check, look globally and you’ll see the CSI’s surge isn’t irrational at all. Let me explain.

The idea stocks are disconnected from reality isn’t exclusive to China. In America, pessimists point to stocks’ 57% rebound that fully erased the winter’s declines, claiming markets are ignoring an historic plunge in GDP, surging unemployment and endless Covid-19 issues with a possible resurgence. They claim bored individual investors are gambling financial relief payments on stocks, inflating a bubble — just like China. Others dismiss European stocks’ rally as a function of government “stimulus,” unlikely to survive rising Covid-19 case counts and economic carnage. Wherever you look, some pundit somewhere offers a litany of reasons stocks shouldn’t rationally keep climbing.

Here and everywhere, these pundits fell prey to the pessimism of disbelief that I detailed in May — the post-bear market tendency to see only negatives and dismiss positives as false or sure to morph into something terrifying. Behind this is a psychological phenomenon called “confirmation bias.” Scarred by the lockdown-driven drop and burned by that big bounce back they never expected, pessimists are desperate to avoid the emotional pain of a repeat. So, instead of accepting their error and changing course, they see anything and everything possible supporting their negativity — and nothing contrary. Any upside feels irrational like 2015 — a bubble set to burst as stocks head into a deep double-dip drop.

But that comparison — and forecasts of a second down leg — are a stretch. Back in 2015, the CSI 300 surged 62.2% from early February to early June before the bubble burst, as investors overoptimistically celebrated China’s market-oriented reforms. Rising markets enticed speculators seeking quick riches. Pessimists claim bullish editorials in the Chinese press back then fanned the furor. They envision parallels now.

Yet that move looks nothing like today’s. Unlike now, the CSI’s huge 2015 spike wasn’t mirrored globally. MSCI’s All-Country World Index — ACWI, a gauge covering 49 developed and Emerging Market countries — rose just 1.9% while Chinese stocks surged. This time, the CSI is trailing the ACWI’s 48.6% gain since March’s low. Also unlike now, that upturn didn’t follow a global bear market. Finally, it takes euphoria to fuel a bubble. Today, nearly everyone talks up risks and worries the rally can’t continue. That doesn’t’ happen with euphoria. Fretting evidences it isn’t euphoria.

Ditching stocks on well-known fears is a backward-looking decision — a classic error. “Double-dip” and “disconnect” fears abound after every single bear market, ever. After 2009’s global market bottom, double-dip doom ranged from possible hot inflation to high unemployment. Stocks soared. In late 2002 and 2003, many argued the “disconnect” between rising stocks and sluggish consumer spending, terrorism and America’s Iraq invasion would drive a double dip. Stocks had a correction in early 2003, but the bull market resumed with gusto in March. Twin plunges are extremely rare.

Many American pundits claim bear markets beginning in 1929 and 1937 were a double dip. But nearly five years separated them. Consider America’s S&P 500 in U.S. dollars for its long history. That index surged 324% in between those bear markets while America’s economy grew. They were fully separate downturns. Regional double dips do happen — the U.S. endured one in the early 1980s and Europe in the early 1990s. China has suffered them. But they’re exceedingly rare.

New bull markets don’t derail easily — bear markets sink expectations so low it’s extremely tough for reality to subsequently disappoint investors. There were 11 S&P 500 bull markets since 1929 before this year’s. Stocks usually soared early, averaging 27.8% returns in the first 180 days. While periodic volatility is normal, the next six months are similarly positive—returns jump to 46.6% on average 12 months from the low. Crucially, these early gains compound through the bull market’s remaining life.

What pessimistic pundits’ confirmation bias and fear makes them miss is that stocks — in China and globally — are doing what they always do early in bull markets: looking far forward. Stocks discount widely known fears, worries and opinions. Then they assess the likely economic outcome over the next approximately three to 30 months. Consider this year. When China announced lockdowns, markets reacted negatively and fast. The CSI fell 7.9% the day after markets reopened following the extended Lunar New Year closure. It reacted negatively again — alongside a bear market in the West — when lockdowns went global. That was all before any economic data showed contraction. Stocks urgently pre-priced the sudden stop to economic activity.

But then markets shifted their focus from the very near term of the three to 30 month to the very far future, when Covid will be old news. That’s what they always do after the panicky terrifying plunge at a bear market’s ending. They knew the lockdowns would drive a steep contraction. They saw many people fearing multiple Covid waves sweeping the world. They expected high unemployment and knew reopening would be uneven worldwide. The floods? Tragic for those affected, but even New York media worry over them. Stocks aren’t overlooking these factors. They just already dealt with them. Pundits seeing irrationality in stocks presume equity investors are somehow blissfully unaware of the huge array of negative headlines around them. Wrong! It’s those thinking investors collectively and markets are irrational that are actually irrational.

This is why investors should exit stocks only if they see a looming, probable negative others don’t and haven’t been pre-priced — not because of widely known fears, which stocks pre-price routinely. Definitely not because of fear from a downturn they just endured — a backward-looking factor detached from anyone’s investment goals.

Slashing stock holdings due to fear doesn’t reduce risk. It actually increases the risk you fail to reach your goals. Good equity investors don’t fight unpredictable volatility and recurring bear market fears. They accept them as the price of the high returns they need. They accept legendary American investor Ben Graham’s timeless logic: “The investor’s chief problem—and even his worst enemy—is likely to be himself.”

The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.

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